5.3 Risks arising from the unregulated nature of virtual instruments usable for payment

The decentralised operation of bitcoin and similar virtual instruments significantly differs from that of the electronic payment instruments currently used by the economic agents, and the lack of supervision and oversight by authorities and of liability rules protecting consumers as well as consumer protection and indemnification rules considerably increases the risks related to the use of these instruments.

The virtual instruments usable for payment have typically appeared in the past few years, during the crisis, to provide an alternative to the legal instruments used in the execution of financial transactions, avoiding the banking system. It is a basic characteristic of these instruments that they can only be used electronically, they do not have issuers supervised by authorities. In order for the transactions to be valid, they have to be authenticated by the network of the given virtual instruments usable for payment i.e. execution of the transactions does not take place through systems supervised by central banks. Typically, the number of a given instrument is limited, it can be generated by virtual mining. This means that with an open source software that requires a large calculation capacity (today of industrial extent), anybody can create more and more units anonymously until the upper limit coded into the system is reached.

In the case of problems with access and the operation of the virtual instruments usable for payment as well as misconduct committed to the detriment of the owners, the participants of the system may suffer significant damages and typically the possibility of indemnification or the mitigation

of damages is not ensured by legislation. As for traditional electronic payment instruments, the accounts holding the money electronically are managed by payment service providers, and their safe and legal operation is supervised and regularly checked by the authorities; thus the usability of the customers’ electronically saved money is ensured. In the case of the bitcoin and the rest of the similarly operating virtual instruments usable for payment, there are no issuing and intermediary institutions operating in a regulated framework but the participants of the system create the virtual instrument usable for payment and they operate the recording of the clearing units along with the system that performs the execution of the transactions. Thus, if during the recording of the bitcoin or the execution of the transactions any problem arose, there is no authority or market participant that would assume responsibility for the users’ money placed into virtual instruments. In the case of transactions initiated by using electronic payment methods, transactions are executed in systems where typically the oversight activity of a central bank ensures the safe, efficient and legally compliant operation of the systems performing the clearing and settlement of the payment transactions. Due to this, transactions are executed within the required time limits, in the method prescribed by legal regulations and safely. As opposed to this, the system enabling the exchange of bitcoins operates without central parties, where transactions are executed using the resources provided jointly by the participants of the system, and the final approval of the execution of the transactions is based on the confirmation of the system participants. Due to this, no institution guarantees the execution of the transactions for the owners of the virtual instruments usable for payment, nor do they compensate for any damages suffered by the customers. In addition, the requirements that define the rules of the execution of the payments and the protection of the customers in the case of electronic payment transactions do not apply to the trading systems that enable the exchange of the instruments.

In the case of virtual instruments, the owners face significant risks during the possession and usage of the instruments because of the lack of consumer protection, while the problems that arise from this may have a negative impact on the traditional electronic payment instruments on the long run. Traditionally, the users of the electronic payment solutions are protected by several legal provisions from the negative consequences of any misconduct and the interruptions occurring during the operation of the payment service providers and the payment systems. Among others, in the case of unauthorised access to the funds electronically stored in the systems of the payment service providers and the execution of transactions not approved by the customers, if the abuse did not take place because of the customer’s fault, the service provider shall restore the account’s original state thus protecting customers from the negative impacts of misconduct. However, the owners of bitcoins or the rest of the virtual instruments that are usable for payment may fall victim to misconduct in several ways. Misconduct may occur when

unauthorised persons gain access to the wallet on the owner’s computer and transfer the bitcoin that is stored there to another account, or even when unauthorised parties access the owner’s bitcoins by hacking the system of an electronic trading place that provides bitcoin wallet services. In such cases, the owners are not insured against the losses they have suffered, and thus they have to bear all the losses. In addition, in the case of purchases made with electronic payment instruments, both the payer and the payee are protected by rules with which it can be ensured that buyers really pay the value of the goods they purchased and the services they used and that the value of the goods sold really reaches the merchants. If the payment provider did not charge the appropriate amount to the payer’s account, the transaction can be reversed in certain cases and thus the customer will not suffer any losses, either. In the case of the bitcoin, there are no similar consumer protection rules, thus in a payment transaction neither the buyer, nor the merchant can be sure that the payment transaction will take place according to the contract. Both the seller and the buyer have to assume a significant exchange rate risk since in the case of the bitcoin, a significant change was observed in the exchange rate in the past period. As a result of this, the price of the purchased goods or services expressed in a real payment instrument at the time of the purchase can only be established with greater uncertainty.

Box 6 Purchases through the Internet with bitcoin and debit cards

In the short term, payment with bitcoins can primarily appear in purchases made through the Internet where, out of the traditional payment solutions, currently bankcard payments can represent the most efficient electronic payment method. Thus, it is expedient to compare the major characteristics of these two solutions (Table 6).

Table 6 Differences between purchases made on the Internet by debit cards and bitcoins

How can one acquire amounts usable for payment?

where are the amounts usable for payments stored?

who is the issuer of the payment instrument?

what are the security features to reduce the chances of fraud?

How are the transactions executed?

How is the loss of the participants in the transaction limited in the case of a system failure or fraud? Bitcoin

– by virtual mining – by purchasing against legal tender – by accepting as counter value of goods or services in a virtual wallet on the user's own computer or at a wallet service provider not supervised by authorities There is no central issuer, it can be acquired by virtual mining or on trading platforms

Debit card

– by credit transfer or cash deposit to payment account – by accepting as counter value of goods or services on a payment account operated by a payment service provider supervised by the competent authority A payment card linked to a payment account is issued by the payment service providers operating the payment account.

It is necessary to enter the security code ensuring access to the virtual wallet to initiate transactions.

In a growing number of cases is necessary to enter other information or a one-time password beside the data found on the card. At the moment of payment the change of At the moment of payment the merchant bitcoin between the virtual wallets is gets a confirmation from the card issuing realized. Afterwards each bitcoin- payment service provider about the transaction must be confirmed by the availability of the funds. On the payment bitcoin network to be valid. In case of account of the cardholder and the amount multiple spending of the same Bitcoin the used is blocked on the payment account of transaction recognized at the first time by the cardholder. Afterwards the merchant the majority of the network will be the final receives the amount of the transaction in one. a few days through the card settlement system overseen by the central bank.

The bitcoin-holder bears all the losses, at most it is possible to reduce the loss only in judicial procedure. Rules of liability and allocation of losses laid down by law, supervision and oversight activity ensure to minimize the losses of the stakeholders.